If you want to know how big a mortgage loan you can get, you're asking yourself the wrong question. You should really be asking how much you can comfortably afford to borrow. Nowadays, most lenders are keen to reassure themselves you can afford to make payments, but they're generally using statistical averages rather than closely examining your individual personality, lifestyle and spending habits.
The Reality-Check Challenge
Luckily, you have the opportunity to conduct a scientific experiment that could tell you precisely how much you can afford in mortgage payments: You can pretend you're already paying down the loan you want. Visit LendingTree's home affordability calculator, and enter your income and current debt payments, and the down payment and mortgage rate figures for the loan you ideally want. Then click through on "Assumptions" to make sure the property taxes, homeowners' association fees and insurance premiums are roughly right. You now have a fair idea of how much it's going to cost you each month to own the property you want, although you may need to add on a bit for essential maintenance and repairs. Deduct from that the equivalent amount you currently pay for the place where you now live in, usually either rent or, if you're an existing homeowner, the costs you're already paying. If you're living rent-free in mom and dad's basement or spare room, the deduction's zero. Easy, huh? Grade school math.
Now for the hard part. Take the difference between what you're going to have to pay and what you're currently paying, and place it in a savings account each month. After six months or a year (though you'll probably have a pretty good idea much sooner), you're going to know whether you can comfortably afford the amount you're planning to borrow.
Regardless of how easily you can afford a mortgage, you're still likely to need a down payment. The main exceptions to that rule are VA loans (ones backed by the Veterans Administration) and USDA loans (those backed by the Department of Agriculture). Neither of those programs automatically require down payments, but they each have very different eligibility criteria. The USDA guarantees mortgages for first-time buyers with good credit who are buying in defined geographical areas. The VA backs loans to veterans and their surviving spouses and those still serving in the military (check eligibility), and is less fussy about credit scores.
People who don't qualify for those programs can be pretty certain they're going to have to find a down payment. Just how much they'll need as a minimum is determined by the type of mortgage they want. Here are some common ones:
- Freddie Mac and Fannie Mae: 3 percent of the home's appraised value. However, those with less than 20 percent should expect to pay insurance premiums to cover the extra risk.
- Federal Housing Administration (FHA): 3.5 percent. Again insurance premiums are mandatory when down payments are small. The good news is the FHA slashed its premiums in 2015.
- Private lenders: There are no set rules, but expect to make a minimum down payment in the region of 20 percent.
Where You're Buying and Your Type of Mortgage
The amount that can be borrowed using government-backed mortgages -- including those from the VA, FHA, Freddie Mac, and Fannie Mae -- is subject to caps determined by the Federal Housing Finance Administration. For many, the most that can be borrowed for single-family units is currently $417,000, although there are several metropolitan areas that have caps between $424,350 and $615,250. For properties in Alaska, Hawaii, Guam, and the U.S Virgin Islands, the maximum is $625,500. In some circumstances, Fannie and Freddie offer higher limits on their "Super Conforming Mortgages."
Of course, providing you can meet its lending criteria, you can always borrow more using a so-called jumbo mortgage from a private lender.
Your Credit Score
Your credit score -- and the credit report from which it's calculated -- is going to be closely scrutinized by lenders. At the moment, and unless you're wanting a VA mortgage, they're going to want to see a pretty high score and very few blots on your report.
To transform a low score into a high one can take years, but it's possible to move a good one up enough to make a difference in a matter of months. According to FICO, the company behind the most widely used scoring systems, these are some of the most effective measures you can take:
- Check your credit report and have any errors you find corrected.
- Monitor your credit score frequently, so you can watch your progress (it's motivating) and head off any problems quickly. LendingTree has a credit score monitoring service that's totally free.
- Set up payment reminders or automated payments so you're never late settling a bill. Even being a little late can hurt your score, though skipping one is much worse.
- Pay down debt. This isn't necessary for fixed-term borrowing with equal monthly payments, but ideally none of your credit card balances should exceed 30 percent of that card's credit limit. If one or more does, it's dragging down your score.
- Confine your rate comparison shopping to a brief period. Normally, each "hard" inquiry on your credit report (one where a lender's thinking of offering you credit) involves a small hit on your score. But, if you're shopping around for the best borrowing deal, that should count as just one inquiry, providing you do your shopping over a few days.
- Don't open other new accounts during the months running up to your mortgage application. Although the hits to your score from hard inquiries and new account openings are small, even a difference of a few points can sometimes affect the rate you're offered, the amount you can borrow -- and whether you're approved at all.
Lenders want to reassure themselves that you're a good bet: that you're going to make timely payments and not default. So they generally check on a number of relevant factors. For example, they may want to look at:
- Your work history to ensure you're not the sort to be regularly unemployed for long periods.
- Your savings to make sure you have enough to meet closing costs and still be able to survive occasional tough times.
- Your household income and existing debts so they can assess your ability to make payments.
Falling short on any of these can see your application declined, the mortgage rate you're offered raised or the amount you're able to borrow reduced.
One last thought: Although lenders are applying quite high standards at the moment, they are in the business of ... well, lending. They want to do a deal with you if possible. You can boost your chances of being approved for the size of mortgage you want if you improve your credit score, reduce your debt, and build your savings in advance.